1099 Vs W2, Does Your Small Business Have Employees Or Contractors?

During the life of most small businesses, every owner might need help producing the deliverables and enlist persons outside their immediate family for help. Now the decision of how the helpers will be paid must be made.

Should I pay this person as a 1099 contractor or W2 employee?

Should they be paid as an independent contractor or withhold taxes from their compensation as an employee? The biggest determining factors should not be what are easiest for the owner but rather what are correct in the eyes of the Internal Revenue Service.

In the past decade, the IRS has developed guidelines and common law rules to help small business owners make the right choice between independent contractor and employee. The decision should be well thought out and well documented in case of possible disputes later from either the helpers or the IRS. The trend has been for the IRS to view all helpers under the direct control of a business owner as their employees not as contractors. This view allows for an easier method of tax collections direct from a single business owner rather than chasing down several independent contractors.

So, be careful with your choice, if the helpers you paid as 1099 contractors are determined later by the IRS as W2 employees then the Trust Fund recovery penalty which is federal income tax, social security and Medicare taxes not withheld will be assessed to the owner.

Below are excerpts direct from the irs.gov web site and might help you make the correct choice.

The general rule is that an individual is an 1099 contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.

Common 1099 and W2 Rules

Facts that provide evidence of the degree of control and independence fall into three categories:

Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)

Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? Does the contractor have business cards, a website; advertise independently?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.